Lecture 6<br />August 16th 2010<br />
The Instruments of Trade Policy<br />
Tariffs in General<br />Tariffs are simply taxes a country places on its imports.<br />Purpose of tariffs:<br />to protect...
Specific Tariffs<br />Specific tariffs involve charging a tax per physical unit imported.<br />For example, <br />US tarif...
Ad Valorem Tariffs<br />Ad valorem tariffs involve charging a tax as a percentage of the value of the good.<br />For examp...
Preferential Duties and the Generalized System of Preferences (GSP)<br />Preferential duties: <br />Tariff rates vary acco...
Permanent Normal Trade Relations Status (PNTR)<br />PNTR status is a way to achieve non-discrimination in trade.<br />If t...
Offshore Assembly Provisions<br />With OAPs, the tariff applies only to the foreign value added.<br />For example, if ther...
Measuring Tariffs<br />This is sometimes referred to as the “height” of tariffs.<br />There are two ways to measure this h...
Unweighted Tariffs<br />Suppose there are 3 imported goods.<br />Good A has a 30% tariff<br />Good B has a 40% tariff<br /...
Weighted Tariffs<br />Suppose there are 3 imported goods.<br />Good A has a 30% tariff and 200 units are imported<br />Goo...
Nominal and Effective Rates of Protection<br />Nominal tariff rates apply only to final products.<br />Effective tariff ra...
Nominal Rate of Protection (NRP)<br />First consider the nominal rate of protection (NRP).<br />NRP = (PDt - PDFT)/ PDFT<b...
Effective Rate of Protection (ERP)<br />First, let’s define value added<br />VA = price of good - price of inputs<br />Now...
ERP<br />When tariffs on inputs > tariffs on final products, <br />ERP < NRP.<br />When tariffs on inputs < tariffs on fin...
ERP: The Bottom Line<br />ERP gives an indication of the effects of the whole tariff structure on industries; NRP only loo...
Export Taxes<br />An export tax is a tax a government places on its own exporters.<br />Are applied for several reasons<br...
Export Subsidies<br />Governments can encourage exports by paying exporters a certain premium per unit exported.<br />Expo...
Non-Tariff Barriers<br />Trade gets restricted in ways not involving taxes:<br />import quotas,<br />“voluntary” export re...
Import Quotas<br />Many countries restrict the quantity of certain imports allowed entry in a given time period (usually a...
“Voluntary” Export Restraints<br />Importing countries “persuade” exporting countries to voluntarily limit their exports.<...
Government Procurement Provisions<br />Some countries require their government to purchase from domestic suppliers unless ...
Domestic Content Provisions<br />Some countries require that a certain percentage of the value of a good sold domestically...
European Border Taxes<br />European (and some other) countries have value added taxes that increase the prices of domestic...
Other Non-Tariff Barriers<br />Administrative classification<br />Restrictions on trade in services<br />Trade-related inv...
The Impact of Trade Policies<br />
Consumer Surplus<br />Consumer surplus (CS) is a measure of the overall well-being of consumers.<br />CS is the area betwe...
Consumer Surplus<br />P<br />P*<br />D<br />Q<br />
Producer Surplus<br />Producer surplus (PS) is a measure of the well-being of producers.<br />PS is the area between the s...
Producer Surplus<br />P<br />S<br /> P*<br />Q<br />
Trade Restrictions in Partial Equilibrium: The Small Country Case<br />What happens when a country imposes a tariff? Its d...
Tariffs: Small Country Case<br />CS falls by area a+b+c+d, <br />or $656.25.<br />PS rises by area a, or $393.75.<br />Rev...
Tariffs: Small Country Case<br />A tariff makes producers better off, but overall, the small country’s welfare falls.<br />
Import Quotas: Small Country Case<br />Quotas and tariffs can be designed to be equivalent.<br />The difference is that wi...
Production Subsidies: Small Country Case<br />Production subsidies lead to deadweight loss because of the expansion of rel...
Export Taxes: Small Country Case<br />An export tax tariff makes consumers better off, but overall, the small country’s we...
Export Subsidies: Small Country Case<br />Export subsidies cause the price in the imposing (i.e., exporting) country to ri...
Export Subsidies: Small Country Case<br />An export subsidy tariff makes producers better off, but overall, the small coun...
Voluntary Export Restraints: Small Country Case<br />Similar to tariffs or quotas, VERs raise the domestic price which<br ...
Tariffs: Large Country Case<br /><ul><li>0</li></ul>Importing country CS falls by a+b+c+d<br />PS rises by area a.<br />Re...
Tariffs: Large Country Case<br />A large country could increase its welfare by imposing a tariff if the revenue extracted ...
Export Taxes: Large Country Case<br /><ul><li>0</li></ul>CS rises by area a.<br />PS falls by areas a+b+c+d<br />Revenue r...
Export Taxes: Large Country Case<br />A large country could increase its welfare by imposing an export tax if the revenue ...
Tariffs in General Equilibrium: Small Country Case<br />In free trade, producer equilibrium is at B0, and consumer equilib...
Trade Restrictions in General Equilibrium: The Large Country Case<br />To understand the effects of protectionism in the l...
Tariffs or Export Taxes<br />(PX/PY)t<br />OCA<br />OCA'<br />Y<br />(PX/PY)FT<br />OCB<br />Y1<br />By imposing a tariff ...
Export Subsidies<br />OCA<br />(PX/PY)FT<br />Y<br />(PX/PY)ES<br />OCB<br />Y2<br />Y1<br />Country A’s terms of trade <b...
Import Quotas<br />OCFTA<br />(PX/PY)FT<br />Y<br />(PX/PY)IQ<br />OCFTB<br />Y1<br />The quota causes the imposing<br />c...
VERs<br />OCFTA<br />(PX/PY)E<br />Y<br />OCFTB<br />Y1<br />The quota decreases trade volume, and causes A’s terms of tra...
Arguments for Interventionist Trade Policies<br />
Is Protectionism Ever a Good Idea?<br />Our trade theories tell us that generally free trade is the best policy.<br />Why,...
Trade Policy as Part of Broader Social Policy Objectives<br />There are a number of common arguments in favor of protectio...
Argument #1: Government Revenue<br />Tariffs, export taxes, and perhaps quotas, can be used to generate government revenue...
Argument #2: National Defense<br />There may be industries that are vital to national security.<br />If these industries a...
Argument #3: Balance of Payments<br />A country may wish to address a trade deficit by limiting imports.<br />This would w...
Argument #4: Terms of Trade<br />We’ve seen from offer curves that a country will improve its terms of trade by imposing a...
TOT2<br />Y<br />TOT1<br />OCUS<br />OCF<br />When the U.S. imposes a<br />tariff on French products,<br />U.S. terms of t...
Y<br />TOT1<br />OCUS<br />OCF<br />However, it is very likely<br />that France will retaliate<br />with tariffs on U.S. p...
Argument #5: Protection to Increase Nat’l Employment<br />Unemployment high? Why not restrict imports?  Wouldn’t this put ...
Argument #5: Protection to Increase Nat’l Employment<br />Bottom line: jobs may be saved in the protected industry, but jo...
Argument #6: Protection  to Increase Employment in a Particular Industry<br />Even if overall employment isn’t increased u...
Argument #7: Protection to Benefit Scarce Factor<br />As we have seen, tariffs redistribute income from the owners of the ...
Other Arguments<br />Protection of certain key “national pride” industries<br />Discriminatory protectionism: the Generali...
Protection to Offset Market Imperfections<br />Trade policy is sometimes used to correct for market failures caused by:<br...
Protection to Offset Externalities<br />Let us consider two types of externalities:<br />Negative consumption externalitie...
Protection to Extract Foreign Monopoly Profit<br />If a foreign company is a global monopolist, a tariff may permit the do...
Protection to Extract Domestic Monopoly Profit<br />If a domestic company is a monopolist, an export tax may permit the go...
Protection as a Response to Int’l Policy Distortions<br />Some protectionist policies by foreign countries may warrant pro...
Tariffs to Offset Dumping<br />Dumping occurs when:<br />one country sells its product at a lower cost in the foreign mark...
Tariffs to Offset Dumping<br />There are three types of dumping:<br />Permanent (or persistent) dumping occurs when a fore...
Tariffs to Offset Dumping<br />Sporadic dumping occurs when the foreign exporter occasionally liquidates a surplus on the ...
Tariffs to Offset Dumping<br />Predatory dumping: the idea is to sell below cost until rivals fold; then the predator can ...
Tariffs to Offset Foreign Subsidies<br />When our trading partners subsidize their industries, we can punish those countri...
Strategic Trade Policy: Fostering Comparative Advantage<br />Some argue that a country can foster comparative advantage by...
Infant Industry Protection<br />Basic idea: <br />a country should protect a new industry from foreign competition until i...
Infant Industry Protection<br />Problems:<br />Are there really economies of scale in the protected industry?  If not, the...
Economies of Scale in a Duopoly Framework<br />Suppose firms take into account the actions of other firms.<br />Suppose al...
Economies of Scale in a Duopoly Framework<br />Reaction functions slope downwards because increased sales by the other fir...
Economies of Scale in a Duopoly Framework<br />A tariff by the home country would shift the reaction function to the right...
Economies of Scale in a Duopoly Framework<br />It may be possible to use protection to help a domestic firm achieve econom...
R&D and Home Firm Sales<br />Suppose a firm can lower its marginal costs by investing in R&D.<br />If the home country imp...
Export Subsidy in Duopoly<br />Suppose a firm can lower its marginal costs with the help of an export subsidy.<br />This m...
Strategic Government Interaction<br />Suppose each country can choose free trade or protectionism.<br />Suppose if Country...
Strategic Government Interaction: Payoff Matrix<br />
Strategic Government Interaction<br />The dominant strategy for each country is protectionism.<br />This is the case even ...
Political Economy and U.S. Trade Policy<br />
The Political Economy of Trade Policy<br />Q: If free trade has so many economic benefits, why is there so much protection...
The Self-Interest Approach to Trade Policy<br />The median-voter model: <br />public decision-makers can increase their re...
The Self-Interest Approach to Trade Policy<br />Interest groups can have great influence.<br />The benefits of protectioni...
The Social Objectives Approach to Trade Policy<br />Some economists argue instead that a government may conduct trade poli...
A Review of U.S. Trade Policy<br />1930: Smoot-Hawley (S-H) Tariff<br />Eventually the S-H Tariff Act caused average tarif...
Reciprocal Trade Act (1934)<br />Congress gave up its authority over trade negotiations to the President.<br />The Preside...
GATT and Multilateralism<br />General Agreement on Tariffs and Trade (GATT) was born in 1947.<br />GATT involved multilate...
GATT: Early Rounds<br />Negotiations (called “rounds”) occurred every few years.<br />The first two rounds were:<br />Gene...
GATT: Early Rounds<br />Other early rounds:<br />England (1951)<br />Geneva (1956)<br />“Dillon Round” (Geneva, 1962)<br /...
GATT: The Kennedy Round<br />In 1962, Congress passed the Trade Expansion Act (TEA).<br />President was authorized to make...
GATT: The Kennedy Round<br />70 countries participated in the Kennedy round.<br />Negotiations went from 1964-1967, and we...
GATT: The Tokyo Round<br />The Trade Reform Act (TRA): 1974<br />President authorized to <br />complete further tariff red...
GATT: The Uruguay Round<br />Tariff levels were by this time quite low.<br />Negotiations began in earnest in 1986.<br />
The Uruguay Round: Agenda<br />Further tariff reductions<br />Reductions in non-tariff barriers<br />Negotiations regardin...
Uruguay Round: Actions<br />Most tariffs to be cut another 34%; others eliminated.<br />MFA to be phased out over 10 year ...
The World Trade Organization (WTO)<br />The Uruguay round was the end of GATT.<br />GATT’s successor, the WTO, was approve...
Trade Policy Issues After the Uruguay Round<br />Many countries wanted further relaxation of protectionism in agriculture....
WTO and the Doha Round<br />WTO trade ministers met in Seattle in 1999 to set an agenda; no agreement was reached due in p...
WTO and the Doha Round<br />The agenda will include continued reductions in trade barriers, cutting farm subsidies, patent...
Recent U.S. Actions<br />“Banana War” with Europe<br />U.S. argued that EU is discriminating against bananas from Central ...
Recent U.S. Actions<br />Extra-Territorial Income Exclusion<br />U.S. provides tax relief to exporting countries.<br />WTO...
Recent U.S. Actions<br />There is much concern in the U.S. over “outsourcing.”<br />For example, call centers in India<br ...
The Conduct of Trade Policy<br />Should trade policy be “rules-based” or “results-based?”<br />Rules-based policies follow...
The Conduct of Trade Policy<br />Results-based policies suggest aggressive unilateral action to ensure that certain result...
Midterm<br />
Midterm Score<br />67 students<br />A: 2<br />B: 3<br />C: 3<br />D: 12<br />F: 47<br />Average:<br />6.67  39%<br />High...
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
IBE303 - Lecture 6
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IBE303 - Lecture 6

  1. 1. Lecture 6<br />August 16th 2010<br />
  2. 2. The Instruments of Trade Policy<br />
  3. 3. Tariffs in General<br />Tariffs are simply taxes a country places on its imports.<br />Purpose of tariffs:<br />to protect domestic (import-competing) industries<br />to raise revenue for the government<br />There are two sorts of tariffs: <br />Specific <br />Ad valorem.<br />
  4. 4. Specific Tariffs<br />Specific tariffs involve charging a tax per physical unit imported.<br />For example, <br />US tariff on frozen orange juice is 7.85¢ per liter.<br />Specific tariffs may be easier to administer.<br />Specific tariffs are less likely to maintain the same degree of protection in times of high inflation.<br />
  5. 5. Ad Valorem Tariffs<br />Ad valorem tariffs involve charging a tax as a percentage of the value of the good.<br />For example, <br />US tariff on golf clubs is 4.4%.<br />Ad valorem tariffs may be more complicated to administer than specific tariffs, but do hold their protective value in the face of inflation.<br />
  6. 6. Preferential Duties and the Generalized System of Preferences (GSP)<br />Preferential duties: <br />Tariff rates vary according to product’s geographic source.<br />The GSP involves developing countries paying lower (or zero) tariffs when exporting to the developed world.<br />
  7. 7. Permanent Normal Trade Relations Status (PNTR)<br />PNTR status is a way to achieve non-discrimination in trade.<br />If the U.S. negotiates a lower tariff with a PNTR country, U.S. tariffs fall for all countries with which the U.S. has a PNTR treaty.<br />This is also called multilateralism (and once was called ‘most favored nation’ status).<br />
  8. 8. Offshore Assembly Provisions<br />With OAPs, the tariff applies only to the foreign value added.<br />For example, if there is a tariff on computers, the tariff is not applied to the value of domestic-made components.<br />
  9. 9. Measuring Tariffs<br />This is sometimes referred to as the “height” of tariffs.<br />There are two ways to measure this height:<br />Unweighted average<br />Weighted average<br />
  10. 10. Unweighted Tariffs<br />Suppose there are 3 imported goods.<br />Good A has a 30% tariff<br />Good B has a 40% tariff<br />Good C has a 10% tariff<br />The unweighted average is the simple average of the three:<br />(30%+40%+10%)/3 = 26.7%<br />Unfortunately, this doesn’t account for the fact that the quantities of each good that are imported may differ.<br />
  11. 11. Weighted Tariffs<br />Suppose there are 3 imported goods.<br />Good A has a 30% tariff and 200 units are imported<br />Good B has a 40% tariff tariff and 100 units are imported<br />Good C has a 10% tariff tariff and 400 units are imported<br />The weighted average is the simple average of the three:<br />
  12. 12. Nominal and Effective Rates of Protection<br />Nominal tariff rates apply only to final products.<br />Effective tariff rates take into account not only tariffs on final products, but also those on inputs into the final product.<br />Basic idea: <br />A tariff on an intermediate good (e.g., steel) raises the cost of many final goods (cars)<br />This reduces the protection afforded to auto makers.<br />
  13. 13. Nominal Rate of Protection (NRP)<br />First consider the nominal rate of protection (NRP).<br />NRP = (PDt - PDFT)/ PDFT<br />NRP is always equal to the tariff on the final product.<br />
  14. 14. Effective Rate of Protection (ERP)<br />First, let’s define value added<br />VA = price of good - price of inputs<br />Now we can define effective rate of protection<br />ERP = (VADt - VADFT)/VADFT<br />
  15. 15. ERP<br />When tariffs on inputs > tariffs on final products, <br />ERP < NRP.<br />When tariffs on inputs < tariffs on final products, <br />ERP > NRP.<br />When tariffs on inputs = tariffs on final products, <br />ERP = NRP.<br />
  16. 16. ERP: The Bottom Line<br />ERP gives an indication of the effects of the whole tariff structure on industries; NRP only looks at particular goods.<br />ERPs have an impact on resource allocation: resources flow out of industries with low ERPs, and into industries with high ERPs.<br />
  17. 17. Export Taxes<br />An export tax is a tax a government places on its own exporters.<br />Are applied for several reasons<br />to raise government revenue.<br />to encourage domestic processing of raw materials.<br />
  18. 18. Export Subsidies<br />Governments can encourage exports by paying exporters a certain premium per unit exported.<br />Export subsidies work like export taxes in reverse.<br />
  19. 19. Non-Tariff Barriers<br />Trade gets restricted in ways not involving taxes:<br />import quotas,<br />“voluntary” export restraints (VERs), and<br />other provisions.<br />
  20. 20. Import Quotas<br />Many countries restrict the quantity of certain imports allowed entry in a given time period (usually a year).<br />Quotas affect the quantity directly and the price indirectly; tariffs do the opposite.<br />However, in most respects quotas and tariffs have the same effects.<br />
  21. 21. “Voluntary” Export Restraints<br />Importing countries “persuade” exporting countries to voluntarily limit their exports.<br />Example: 1.68 million Japanese cars permitted annually beginning in 1981.<br />There is an implied threat of tariffs or quotas if exporting country doesn’t comply.<br />VERs exist for political reasons, not economically valid ones.<br />
  22. 22. Government Procurement Provisions<br />Some countries require their government to purchase from domestic suppliers unless the imported version is substantially cheaper.<br />Example: <br />“Buy American” Act requires many U.S. government purchases to be from domestic firms unless domestic bid is more than 6% higher.<br />
  23. 23. Domestic Content Provisions<br />Some countries require that a certain percentage of the value of a good sold domestically must consist of domestic components or labor.<br />Example: <br />NAFTA members do not allow duty-free access to goods unless at least 62.5% of the goods’ value originates in NAFTA countries.<br />
  24. 24. European Border Taxes<br />European (and some other) countries have value added taxes that increase the prices of domestically produced goods.<br />To compensate, European countries impose tariffs on imported products.<br />
  25. 25. Other Non-Tariff Barriers<br />Administrative classification<br />Restrictions on trade in services<br />Trade-related investment measures<br />Exchange rate controls<br />Quality provisions<br />Packaging and labeling requirements<br />
  26. 26. The Impact of Trade Policies<br />
  27. 27. Consumer Surplus<br />Consumer surplus (CS) is a measure of the overall well-being of consumers.<br />CS is the area between the demand curve and the price.<br />CS varies inversely with the price.<br />
  28. 28. Consumer Surplus<br />P<br />P*<br />D<br />Q<br />
  29. 29. Producer Surplus<br />Producer surplus (PS) is a measure of the well-being of producers.<br />PS is the area between the supply curve and the price.<br />PS varies directly with price.<br />
  30. 30. Producer Surplus<br />P<br />S<br /> P*<br />Q<br />
  31. 31. Trade Restrictions in Partial Equilibrium: The Small Country Case<br />What happens when a country imposes a tariff? Its domestic price rises.<br />Therefore, tariffs: <br />benefit domestic producers<br />harm domestic consumers<br />generate tariff revenue for the government<br />
  32. 32. Tariffs: Small Country Case<br />CS falls by area a+b+c+d, <br />or $656.25.<br />PS rises by area a, or $393.75.<br />Revenue rises by area c, or $175.<br />Deadweight loss is areas b+d, <br />or $87.50.<br />P<br />S<br />$1.35<br />a<br />c<br />d<br />b<br />$1<br />D<br />Q<br />2000<br />1750<br />1000<br />1250<br />14-32<br />
  33. 33. Tariffs: Small Country Case<br />A tariff makes producers better off, but overall, the small country’s welfare falls.<br />
  34. 34. Import Quotas: Small Country Case<br />Quotas and tariffs can be designed to be equivalent.<br />The difference is that with quotas there is no revenue collected.<br />Instead rent will be captured by<br />holders of import licenses or <br />the government if it auctions the licenses, or<br />foreign suppliers, if they organize.<br />The welfare implications of the quota are otherwise the same as for tariffs.<br /><ul><li>0</li></li></ul><li>Production Subsidies: Small Country Case<br />A $1 subsidy has the effect of <br />shifting the supply curve to the right.<br />CS doesn’t change, because consumers still pay $5.<br />PS rises by areas a+b<br />The cost of the subsidy is a+b+c<br />Deadweight loss is areas c.<br />P<br />S<br />S'<br />$6<br />b<br />a<br />c<br />$5<br />D<br />Q<br />100<br />190<br />120<br />160<br />14-35<br />
  35. 35. Production Subsidies: Small Country Case<br />Production subsidies lead to deadweight loss because of the expansion of relatively inefficient production.<br />However, the DWL is less than would have occurred if an equivalent tariff or quota were used.<br /><ul><li>0</li></li></ul><li>Export Taxes: Small Country Case<br />Export taxes cause the price in the imposing (i.e., exporting) country to fall, since some of what had been exported is not anymore.<br />We’d predict an increase in CS, a decrease in PS, and a gain in revenue.<br /><ul><li>0</li></li></ul><li>Export Taxes: Small Country Case<br /><ul><li>0</li></ul>CS rises by area a.<br />PS falls by areas a+b+c+d.<br />Revenue rises by area c.<br />DWL is b+d.<br />P<br />S<br />PFT<br />b<br />d<br />a<br />c<br />PET<br />D<br />Q<br />
  36. 36. Export Taxes: Small Country Case<br />An export tax tariff makes consumers better off, but overall, the small country’s welfare falls.<br />
  37. 37. Export Subsidies: Small Country Case<br />Export subsidies cause the price in the imposing (i.e., exporting) country to rise, since more of what is produced is now exported.<br />We’d predict an decrease in CS, an increase in PS.<br />The subsidy will generate cost, not revenue.<br /><ul><li>0</li></li></ul><li>Export Subsidies: Small Country Case<br /><ul><li>0</li></ul>CS falls by area a+b<br />PS rises by areas a+b+c+d+e<br />Subsidy cost is b+c+d+e+f<br />Overall effect is a loss: b+f<br />P<br />S<br />PES<br />c<br />e<br />a<br />d<br />b<br />f<br />PFT<br />D<br />Q<br />
  38. 38. Export Subsidies: Small Country Case<br />An export subsidy tariff makes producers better off, but overall, the small country’s welfare falls.<br />
  39. 39. Voluntary Export Restraints: Small Country Case<br />Similar to tariffs or quotas, VERs raise the domestic price which<br />lowers CS<br />raises PS<br />Rent, however, is captured by the exporting country.<br />The imposing country will lose not only the DWL triangles, but also the rent rectangle; welfare falls.<br /><ul><li>0</li></li></ul><li>Tariffs: Large Country Case<br />In the previous analysis, the tariff caused the imposing country’s price to rise by the full amount of the tariff.<br />This would mean that the imposing country is “small”; if it imposes a tariff, it is unable to affect the world price.<br />What if a country is not “small”?<br /><ul><li>0</li></li></ul><li>Tariffs: Large Country Case<br /><ul><li>0</li></ul>The tariff causes price <br />to rise in the importing <br />country; P falls in the <br />exporting country.<br />P<br />S<br />P<br />S<br />a<br />c<br />b<br />d<br />PFT<br />e<br />D<br />D<br />Q<br />Q<br />Exporting Country<br />Importing Country<br />14-45<br />
  40. 40. Tariffs: Large Country Case<br /><ul><li>0</li></ul>Importing country CS falls by a+b+c+d<br />PS rises by area a.<br />Revenue increases by areas c+e<br />Overall effect: e–(b+d)<br />P<br />S<br />P<br />S<br />a<br />c<br />b<br />d<br />PFT<br />e<br />D<br />D<br />Q<br />Q<br />Exporting Country<br />Importing Country<br />14-46<br />
  41. 41. Tariffs: Large Country Case<br />A large country could increase its welfare by imposing a tariff if the revenue extracted from the exporting country (area e) is bigger than the deadweight loss (areas b+d).<br />This assumes that the exporting country does not retaliate.<br /><ul><li>0</li></li></ul><li>Import Quotas: Large Country Case<br />As with the tariff, IQs cause prices in the importing country to rise, and prices in the exporting country to fall.<br />As with the tariff, if enough of the quota rent is transferred from the exporting country to offset the deadweight loss, a quota can increase a country’s overall welfare.<br />This also assumes no retaliation.<br /><ul><li>0</li></li></ul><li>VERs: Large Country Case<br />As with the tariff and the quota, VERs cause prices in the importing country to rise, and prices in the exporting country to fall.<br />However, unlike quotas rent generated is captured by the exporting country.<br />VERs are welfare-diminishing even in the large country case.<br /><ul><li>0</li></li></ul><li>Export Taxes: Large Country Case<br />In the previous analysis, the export tax caused the imposing country’s price to fall by the full amount of the tax.<br />If the exporting country is large, its price will fall somewhat but the price in the importing country will also rise.<br /><ul><li>0</li></li></ul><li>Export Taxes: Large Country Case<br /><ul><li>0</li></ul>The export tax causes the price to fall in the <br />exporting country and rise in the importing <br />country.<br />S<br />P<br />P<br />S<br />e<br />PFT<br />b<br />d<br />a<br />c<br />D<br />D<br />Q<br />Q<br />Exporting Country<br />Importing Country<br />14-51<br />
  42. 42. Export Taxes: Large Country Case<br /><ul><li>0</li></ul>CS rises by area a.<br />PS falls by areas a+b+c+d<br />Revenue rises by areas c+e<br />S<br />P<br />P<br />S<br />e<br />PFT<br />b<br />d<br />a<br />c<br />D<br />D<br />Q<br />Q<br />Exporting Country<br />Importing Country<br />14-52<br />
  43. 43. Export Taxes: Large Country Case<br />A large country could increase its welfare by imposing an export tax if the revenue extracted from the importing country (area e) is bigger than the deadweight loss (areas b+d).<br />This assumes that the importing country does not retaliate.<br /><ul><li>0</li></li></ul><li>Export Subsidies: Large Country Case<br />CS falls.<br />PS rises.<br />But there is no revenue; instead cost.<br />Overall, export subsidies are welfare-diminishing for small countries and for large countries.<br /><ul><li>0</li></li></ul><li>Trade Restrictions in General Equilibrium: The Small Country Case<br />We can use general equilibrium analysis to better understand the economy-wide effects of protection.<br />A tariff on imports of good Y will stimulate domestic production.<br />The economy winds up on a lower indifference curve.<br />
  44. 44. Tariffs in General Equilibrium: Small Country Case<br />In free trade, producer equilibrium is at B0, and consumer equilibrium is at C0. The tariff changes production to point B1;consumption moves to C1 (on a lower indifference curve).<br />Y<br />C0<br />C1<br />B1<br />B0<br />Px/Py(1+t)<br />(Px/Py)0<br />X<br />14-56<br />
  45. 45. Trade Restrictions in General Equilibrium: The Large Country Case<br />To understand the effects of protectionism in the large country case we can use offer curve analysis.<br />
  46. 46. Tariffs or Export Taxes<br />(PX/PY)t<br />OCA<br />OCA'<br />Y<br />(PX/PY)FT<br />OCB<br />Y1<br />By imposing a tariff or an export <br />tax, Country A decreases trade <br />volume, but improves its terms <br />of trade (note: B’s terms of trade <br />deteriorate).<br />Y2<br />X2<br />X1<br />X<br />
  47. 47. Export Subsidies<br />OCA<br />(PX/PY)FT<br />Y<br />(PX/PY)ES<br />OCB<br />Y2<br />Y1<br />Country A’s terms of trade <br />deteriorate; volume rises.<br />X1<br />X2<br />X<br />
  48. 48. Import Quotas<br />OCFTA<br />(PX/PY)FT<br />Y<br />(PX/PY)IQ<br />OCFTB<br />Y1<br />The quota causes the imposing<br />country’s terms of trade to <br />improve, and trade volume to <br />fall.<br />Y2<br />OCIQA<br />X1<br />X<br />X2<br />
  49. 49. VERs<br />OCFTA<br />(PX/PY)E<br />Y<br />OCFTB<br />Y1<br />The quota decreases trade volume, and causes A’s terms of trade to deteriorate.<br />Y2<br />OCVERB<br />X1<br />X<br />
  50. 50. Arguments for Interventionist Trade Policies<br />
  51. 51. Is Protectionism Ever a Good Idea?<br />Our trade theories tell us that generally free trade is the best policy.<br />Why, then, is there so much protectionism?<br />What are the arguments for protectionism, and are any of them valid?<br />
  52. 52. Trade Policy as Part of Broader Social Policy Objectives<br />There are a number of common arguments in favor of protection.<br />These may help certain groups within a country, or may help a nation achieve some overall goal.<br />
  53. 53. Argument #1: Government Revenue<br />Tariffs, export taxes, and perhaps quotas, can be used to generate government revenue.<br />Trade taxes are attractive because:<br />They are easy to collect.<br />For developing countries, there may not be much income to tax.<br />If country is large, it can pass some of the tax burden to trading partners.<br />In the longer term, income or consumption taxes may be better choices.<br />
  54. 54. Argument #2: National Defense<br />There may be industries that are vital to national security.<br />If these industries are diminished because of import penetration, the country may be vulnerable during times of conflict.<br />Could other policies (such as stockpiling or production subsidies) be better?<br />
  55. 55. Argument #3: Balance of Payments<br />A country may wish to address a trade deficit by limiting imports.<br />This would work if exports were not also diminished.<br />However, a number of factors (e.g., retaliation by trading partners, a reduction of income abroad, a rise in value of domestic currency) make it likely that exports will fall.<br />There is no guarantee that this approach will work.<br />
  56. 56. Argument #4: Terms of Trade<br />We’ve seen from offer curves that a country will improve its terms of trade by imposing a tariff or a quota, as long as it isn’t “small.”<br />However, this assumes that the trading partner does not retaliate.<br />
  57. 57. TOT2<br />Y<br />TOT1<br />OCUS<br />OCF<br />When the U.S. imposes a<br />tariff on French products,<br />U.S. terms of trade improve<br />(although volume decreases).<br />X<br />
  58. 58. Y<br />TOT1<br />OCUS<br />OCF<br />However, it is very likely<br />that France will retaliate<br />with tariffs on U.S. products.<br />Overall, the volume of trade<br />declines, and the U.S. terms<br />of trade may go up, down, <br />or stay the same.<br />X<br />
  59. 59. Argument #5: Protection to Increase Nat’l Employment<br />Unemployment high? Why not restrict imports? Wouldn’t this put Americans to work?<br />No, because:<br />Reduced income of trading partner lowers their demand for our exports.<br />Our trading partners will likely retaliate.<br />Our protection may trigger a dollar appreciation.<br />
  60. 60. Argument #5: Protection to Increase Nat’l Employment<br />Bottom line: jobs may be saved in the protected industry, but jobs in our export industries will be lost.<br />In the U.S., export-industry jobs pay better on average than import-competing industries.<br />
  61. 61. Argument #6: Protection to Increase Employment in a Particular Industry<br />Even if overall employment isn’t increased under protectionism, tariffs can be used to increase employment in a particular industry.<br />This will be costly, however. Consumers will be paying for every job created.<br />A production subsidy might be a better idea.<br />
  62. 62. Argument #7: Protection to Benefit Scarce Factor<br />As we have seen, tariffs redistribute income from the owners of the relatively abundant factor to the owners of the relatively scarce factor.<br />If this is the goal, fine: it will be costly, however.<br />
  63. 63. Other Arguments<br />Protection of certain key “national pride” industries<br />Discriminatory protectionism: the Generalized System of Preferences (GSP)<br />
  64. 64. Protection to Offset Market Imperfections<br />Trade policy is sometimes used to correct for market failures caused by:<br />externalities,<br />foreign monopoly power, or<br />domestic monopoly power.<br />
  65. 65. Protection to Offset Externalities<br />Let us consider two types of externalities:<br />Negative consumption externalities: the consumption of a good by an individual may damage other individuals or society. <br />Example: tobacco<br />If the costs to society are ignored, too much of the good gets consumed.<br />Positive production externalities: the production of a good yields benefits that affect other individuals or society.<br />Example: skills that workers acquire at a firm can benefit other firms that might hire away the worker.<br />If costs to society are ignored, too little is produced.<br />
  66. 66. Protection to Extract Foreign Monopoly Profit<br />If a foreign company is a global monopolist, a tariff may permit the domestic country to capture some of the monopolist’s profits.<br />However, world efficiency and welfare are diminished because of the tariff.<br />Would the foreign country retaliate?<br />
  67. 67. Protection to Extract Domestic Monopoly Profit<br />If a domestic company is a monopolist, an export tax may permit the government to capture some of the monopolist’s profits and transfer some of it back to consumers.<br />
  68. 68. Protection as a Response to Int’l Policy Distortions<br />Some protectionist policies by foreign countries may warrant protectionism in response.<br />We’ll consider protection to offset<br />dumping<br />foreign subsidies<br />
  69. 69. Tariffs to Offset Dumping<br />Dumping occurs when:<br />one country sells its product at a lower cost in the foreign market than in its domestic market, or when<br />one country sells its product below cost in the foreign market.<br />
  70. 70. Tariffs to Offset Dumping<br />There are three types of dumping:<br />Permanent (or persistent) dumping occurs when a foreign firm continually sells its product for a lower price than domestic firms.<br />Often, this is because the firm faces competition when exporting, but has market power at home.<br />
  71. 71. Tariffs to Offset Dumping<br />Sporadic dumping occurs when the foreign exporter occasionally liquidates a surplus on the domestic market.<br />Since this sort is short-term by definition, tariffs probably do more harm than good here.<br />
  72. 72. Tariffs to Offset Dumping<br />Predatory dumping: the idea is to sell below cost until rivals fold; then the predator can raise price to monopoly level.<br />However, domestic firms could then enter the market again.<br />It isn’t clear why a firm would want to do this.<br />Still, if this behavior occurs it is probably inefficient.<br />
  73. 73. Tariffs to Offset Foreign Subsidies<br />When our trading partners subsidize their industries, we can punish those countries with countervailing duties.<br />Foreign subsidies lower prices for domestic consumers.<br />Still, foreign subsidies may harm domestic producers.<br />
  74. 74. Strategic Trade Policy: Fostering Comparative Advantage<br />Some argue that a country can foster comparative advantage by “strategic” trade policy.<br />Possibilities include<br />Protection of infant industries<br />Protection to take advantage of economies of scale<br />Protection to promote exports through research and development<br />
  75. 75. Infant Industry Protection<br />Basic idea: <br />a country should protect a new industry from foreign competition until it grows up and gets big enough to realize economies of scale; that country may develop a comparative advantage!<br />It is plain that domestic consumers will have to pay for this, but they may eventually benefit from having a globally efficient producer.<br />
  76. 76. Infant Industry Protection<br />Problems:<br />Are there really economies of scale in the protected industry? If not, then the industry will never pay back what it cost to protect it.<br />Protection may simply lead to inefficiency.<br />There are typically factors at work to preserve the protection forever.<br />
  77. 77. Economies of Scale in a Duopoly Framework<br />Suppose firms take into account the actions of other firms.<br />Suppose also there are economies of scale present.<br />We can examine the effects of protection by considering each firm’s reaction function.<br />
  78. 78. Economies of Scale in a Duopoly Framework<br />Reaction functions slope downwards because increased sales by the other firm will depress price and profits, so sales are reduced.<br />Xi*<br />H<br />(foreign-firm sales)<br />F<br />Equilibrium is reached at point E<br />E<br />F<br />H<br />Xi<br />(home-firm sales)<br />
  79. 79. Economies of Scale in a Duopoly Framework<br />A tariff by the home country would shift the reaction function to the right, since the increased output lowers the home firm’s marginal cost.<br />Xi*<br />H'<br />H<br />(foreign-firm sales)<br />F<br />This reduces the foreign firm’s <br />output and increases its marginal costs.<br />F'<br />E<br />F<br />E'<br />F'<br />H'<br />H<br />Xi<br />(home-firm sales)<br />
  80. 80. Economies of Scale in a Duopoly Framework<br />It may be possible to use protection to help a domestic firm achieve economies of scale and an expanded market share.<br />However, the foreign country may retaliate.<br />
  81. 81. R&D and Home Firm Sales<br />Suppose a firm can lower its marginal costs by investing in R&D.<br />If the home country imposes a tariff, the home firm’s sales may rise.<br />The increase in sales permits greater R&D investment; this lowers marginal costs and increases sales at the expense of the foreign firm.<br />Retaliation may occur.<br />
  82. 82. Export Subsidy in Duopoly<br />Suppose a firm can lower its marginal costs with the help of an export subsidy.<br />This may cause the foreign firm to exit the market.<br />However, the foreign government may retaliate with their own export subsidy.<br />
  83. 83. Strategic Government Interaction<br />Suppose each country can choose free trade or protectionism.<br />Suppose if Country I pursues free trade and Country II also does so, each country’s welfare is $100.<br />If Country I pursues free trade but Country II engages in protectionism, Country I’s welfare is $50 and Country II’s is $120.<br />If both countries are protectionist, welfare of each is $60.<br />
  84. 84. Strategic Government Interaction: Payoff Matrix<br />
  85. 85. Strategic Government Interaction<br />The dominant strategy for each country is protectionism.<br />This is the case even though free trade would enhance both countries’ welfare.<br />
  86. 86. Political Economy and U.S. Trade Policy<br />
  87. 87. The Political Economy of Trade Policy<br />Q: If free trade has so many economic benefits, why is there so much protectionism?<br />A: The political economy of trade policy must be considered.<br />Two main areas examine these political factors: <br />the self-interest approach, and<br />the social objectives approach.<br />
  88. 88. The Self-Interest Approach to Trade Policy<br />The median-voter model: <br />public decision-makers can increase their re-election chances by voting to satisfy the median voter.<br />This should mean that the will of the majority is followed.<br />However, if some parties do not have full information, some policies that benefit only a few may be enacted.<br />
  89. 89. The Self-Interest Approach to Trade Policy<br />Interest groups can have great influence.<br />The benefits of protectionist policies to interest group members may be great; the costs to the many other individuals may be so diffuse that no one individual has incentive to acquire information or participate.<br />
  90. 90. The Social Objectives Approach to Trade Policy<br />Some economists argue instead that a government may conduct trade policy in order to meet certain social objectives, such as<br />avoiding loss of real incomes of certain groups,<br />minimizing consumer loss, or<br />improving real incomes of disadvantaged groups.<br />Gov’t must stick to its guns; otherwise credibility suffers.<br />
  91. 91. A Review of U.S. Trade Policy<br />1930: Smoot-Hawley (S-H) Tariff<br />Eventually the S-H Tariff Act caused average tariff levels to rise to about 50%.<br />Very quickly, our trading partners retaliated, and over the next three years U.S. exports fell dramatically.<br />It is said that S-H put the “Great” in the Great Depression.<br />
  92. 92. Reciprocal Trade Act (1934)<br />Congress gave up its authority over trade negotiations to the President.<br />The President was authorized to enter into bilateral negotiations with trading partners.<br />Congress only authorized item-by-item reductions.<br />Bottom line: tariffs fell, but slowly and painstakingly.<br />
  93. 93. GATT and Multilateralism<br />General Agreement on Tariffs and Trade (GATT) was born in 1947.<br />GATT involved multilateral negotiations to lower trade barriers.<br />In general GATT supports non-discrimination in trade.<br />GATT established of the Most-Favored Nation principle (now called ‘Normal Trade Relations’).<br />
  94. 94. GATT: Early Rounds<br />Negotiations (called “rounds”) occurred every few years.<br />The first two rounds were:<br />Geneva (1947), and<br />France (1949).<br />These first rounds were very successful, mainly because protectionist groups within each country hadn’t gotten organized.<br />
  95. 95. GATT: Early Rounds<br />Other early rounds:<br />England (1951)<br />Geneva (1956)<br />“Dillon Round” (Geneva, 1962)<br />These rounds were less successful than the first two, but progress was made.<br />
  96. 96. GATT: The Kennedy Round<br />In 1962, Congress passed the Trade Expansion Act (TEA).<br />President was authorized to make tariff cuts across the board, not just item-by-item.<br />Trade Adjustment Assistance: industries “damaged” by imports could receive unemployment compensation and retraining for workers.<br />
  97. 97. GATT: The Kennedy Round<br />70 countries participated in the Kennedy round.<br />Negotiations went from 1964-1967, and were named in memory of President Kennedy.<br />Tariffs on manufactured goods were reduced by one-third.<br />
  98. 98. GATT: The Tokyo Round<br />The Trade Reform Act (TRA): 1974<br />President authorized to <br />complete further tariff reductions of 60%.<br />get rid of any tariff under 5% (“nuisance” tariffs).<br />The Tokyo round ended in 1979, with average tariff reductions of 30%.<br />
  99. 99. GATT: The Uruguay Round<br />Tariff levels were by this time quite low.<br />Negotiations began in earnest in 1986.<br />
  100. 100. The Uruguay Round: Agenda<br />Further tariff reductions<br />Reductions in non-tariff barriers<br />Negotiations regarding the Multi-Fiber Agreement (MFA)<br />Trade in services<br />Anti-dumping duties<br />Agricultural protection<br />Intellectual property rights<br />
  101. 101. Uruguay Round: Actions<br />Most tariffs to be cut another 34%; others eliminated.<br />MFA to be phased out over 10 year period.<br />Many remaining quota to be converted to tariffs.<br />Patent protection to be tightened somewhat.<br />Very little progress was made with services.<br />Agricultural subsidies to be cut over a 6 - 10 year period.<br />
  102. 102. The World Trade Organization (WTO)<br />The Uruguay round was the end of GATT.<br />GATT’s successor, the WTO, was approved during the Uruguay round.<br />WTO was established January 1, 1995.<br />WTO has 148 member countries (Cambodia most recently).<br />In theory, WTO has a stronger dispute-settling mechanism.<br />
  103. 103. Trade Policy Issues After the Uruguay Round<br />Many countries wanted further relaxation of protectionism in agriculture.<br />Developed countries wanted to discuss labor and environmental standards.<br />Other issues being discussed included trade in services, anti-trust policy, the Multi-Fiber Agreement phase-out, and others.<br />
  104. 104. WTO and the Doha Round<br />WTO trade ministers met in Seattle in 1999 to set an agenda; no agreement was reached due in part to anti-trade demonstrations.<br />WTO members met in Doha, Qatar in November of 2001 to set an agenda for the round.<br />An attempt at meeting in Mexico City ended bitterly in 2003.<br />Negotiations still haven’t started.<br />
  105. 105. WTO and the Doha Round<br />The agenda will include continued reductions in trade barriers, cutting farm subsidies, patent laws, and other issues.<br />Doha is supposed to be the round that addresses developing countries’ concerns.<br />
  106. 106. Recent U.S. Actions<br />“Banana War” with Europe<br />U.S. argued that EU is discriminating against bananas from Central and South America.<br />WTO sided with the U.S.<br />Hormone-treated U.S. beef<br />Europe has objected to importation of U.S. beef on health grounds.<br />WTO allowed U.S. to impose tariffs on some European products.<br />An agreement was reached in 2009.<br />
  107. 107. Recent U.S. Actions<br />Extra-Territorial Income Exclusion<br />U.S. provides tax relief to exporting countries.<br />WTO has ruled this to be illegal.<br />U.S. has unilaterally imposed tariffs on steel and textiles.<br />U.S. has had a long-term dispute with Canada regarding softwood lumber.<br />U.S. has been active in negotiating bilateral free trade agreements outside of the WTO framework.<br />
  108. 108. Recent U.S. Actions<br />There is much concern in the U.S. over “outsourcing.”<br />For example, call centers in India<br />In the short run, outsourcing causes job losses and other dislocations.<br />In the longer term, the U.S. economy may benefit from this specialization, and may even gain jobs.<br />
  109. 109. The Conduct of Trade Policy<br />Should trade policy be “rules-based” or “results-based?”<br />Rules-based policies follow rules embodied by the WTO and similar organizations.<br />These embrace the normal trade relations concept.<br />These follow WTO standards on anti-dumping duties, countervailing duties, etc.<br />
  110. 110. The Conduct of Trade Policy<br />Results-based policies suggest aggressive unilateral action to ensure that certain results are achieved.<br />For example, the U.S. may demand penetration of a particular foreign market of a certain percentage.<br />Failure by the trading partner to comply would result in trade sanctions.<br />This notion is also referred to as “industrial policy” or “managed trade.”<br />
  111. 111. Midterm<br />
  112. 112. Midterm Score<br />67 students<br />A: 2<br />B: 3<br />C: 3<br />D: 12<br />F: 47<br />Average:<br />6.67  39%<br />High:<br />17  100% class grade<br />Grade<br />A >= 85% <br />B >= 70%, < 85%<br />C >= 60%, < 70%<br />D >= 50%, < 60%<br />F < 50%<br />

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